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CHAPTER 1: INTRODUCTION

Background of study

Malaysia is a small and open economy which has middle income country. Malaysia is a country on the move. Today, Malaysia becomes an export-driven economy which accelerates one’s by high technology, knowledge-based and capital-intensive industries. Malaysia’s economy achieves successes in economic development because of economy transformation in an effective public policy. The role of policy not only can increase the economic growth but also can achieve the goal in the different development stages (Nabulsi, 2001). Thus, the government plays an important role in economic development.

The question of the relationship between the government expenditure and economic growth has been created a lot of interest and attention among the economist and policy makers. By understanding the relationship within it, may help in building a more goal orientated policy. Therefore, studies on this topic has been made and argued since decades ago. Furthermore, it has also stimulated controversy in macroeconomics studies. This interest has led to empirical studies to address several economic doubts, which related to the government expenditure and the economic growth of the country.

Gwartney, Holcombe and Lawson (1998) noticed when the country has moved towards the economic freedom and open market, that government expenditure will increased accordingly. A lot of empirical studies were carried out to examine the effect of economic growth on government expenditure. However the results of each country lead to different conclusion; where some countries show positive relationship and some countries not. Samudram, Nair and Vaithilingam (2009) state a similar finding based on several studies regarding the relationship of government expenditure and economic growth and the results are inconclusive. Landau (1983) studies noticed that the effect of government expenditure on economic growth in 96 countries and finds a negative relationship between government spending and economic growth. Meanwhile, Sinha (1998) found positive relationship between economic growth and government expenditure in Malaysia for the period of 1950-1992.

There are two schools of thought called Wagner’s law, named after the nineteenth century German Professor Adolf Wagner, and the other one the Keynesian views which were suggested by the 20th century British economist John Maynard Keynes. There are also separated though like big and small government. According to Sinha (1998), Wagner’s law is the first thought that illustrated out the possible relationship between economic growth and the growth of government activity. Sinha (1998) reported that “Adolf Wagner was probably the firstscholar to recognize a positive correlation between economic growth and thegrowth of government activity”. In addition, Henrekson (1993) pointed out from Wagner’s law three main reasons for the increase in the government’s role. In a simple way, Wagner’s law is interpreted as to say that government expenditure is a consequence of a growing economy. First, Industrialization and modernization would lead to a substitution of public for private activities and result in increasing government expenditures on law and order as well as on contractual enforcement. Secondly, an increase in real income would lead to an expansion of the income elastic “cultural and welfare” expenditures. Wagner cited two areas which are education and culture in which the government could be a better provider than the private sector. Thirdly, natural monopolies such as railroads had to be taken over by the government because the running cost of such kind of activities are too expensive and the private sector would be unable to obtain such huge investment to finance the development of these activities.

FIGURE 1.1.1: THE WANGER’S LAW

Wagner’s Law

Source: Drawn by author

On the other hand, the other economic interpretation for government expenditure and growth is explained by the Keynesian view. The positive contribution in government expenditure economic growth will be based on the multiplier effects stated in the Keynesian model.

Keynesian formula consists of the following composition:

Y = C + I + G +Xn ………………………………………….. (1)

where,

Y = the aggregate output (GDP)

C = the consumption

I = the investment

G = the government expenditure

Xn = the net exports (exports-imports)

FIGURE 1.1.2: THE KEYNESIAN VIEWS

Wagner’s Law

Source: Drawn by author

As we have mentioned earlier, this topic has created enormous attention among researchers with many extensive empirical works that have been carried out to test these theories but unfortunately the outcome of these studies has been of a mixed conclusion. The causation of economic growth and government expenditure can be unidirectional, bidirectional or no causality.

Unidirectional causality can be running from government expenditure to economic growth and vice versa. This paper is adapting the Keynesian view to examine the relationship between government expenditure and economic growth.

Several studies on causality have been carried out with several conclusions. Sinha (1998) using augmented Granger causality test finds no evidence of causality between GDP and government expenditure in Malaysia for the time period 1950-1992. Again later, Dogan and Tang (2006) find no empirical evidence to support either of the two theories for Malaysia when using data from 1960 to 2002. While Tang (2001) finds a short-run causality that runs from national income to government expenditure using data from 1960-1998. In all the studies that have been carried out so far, the outcomes are still open for debate. Therefore, the purpose of this paper is to examine the relationship between government expenditure, particularly in economic development expenditure and general development expenditure. This study will cover the government expenditure from year 1981-2013, limitation in obtaining the earlier data has also became one of the reason that the study starting from 1981 and the year 2013, which is the latest data that can be obtain, in order to find as exact as we could. The source of data is from the website Asian Development Bank: Key Indicators for Asia and the Pacific.

1.2 Problem Statement

Statistics from Economic Planning Unit of Malaysia and International Financial Statistics of International Monetary Fund shows that the Malaysian government expenditure’s trend and real GDP per capita’s trend shows almost a consistent increase throughout the period of 1981 until 2013. At the same time its real GDP per capita also shows the same trend.

Figure 1.2: The trend of the total government expenditure and real GDP per capita in year 1981-2013

Source: Economic Planning Unit of Malaysia

Starting with the New Economic Policy (NEP) in the 1970’s with its objective to restore the ethnic balance of the Bumiputera population through investment in human capital, the Malaysian government was directly and heavily involved in economic activity. This involvement or the so called government intervention in the economy has led the Malaysian federal government expenditure to increase steadily. According to Economic Planning Unit (EPU) Malaysia, the report in year 2003 shows that the percentage of total expenditure relative to GDP in 1970 to 1980 has increased about 25% to 33%. Meanwhile, in year 1981, statistics from EPU also show that the total Malaysian centre government expenditure has jumped about 41% from previous year total expenditure while the development expenditure growth percentage of that year compared to the previous year hiked about 52%.

EPU Malaysia report that, by looking into the ratio of development expenditure on total expenditure, it is about 1:3 in 1980. While in the next year, the ratio has increase and achieved a new height at 1:2. In 1982, the total government expenditure showed about the same pattern as in year 1981. However the scenario changed in 1983.In year 1983 the Malaysian government focused its privatization policy as one of the national policies. This policy has brought more capitalization to the nation, shifted the government led growth to private sector led growth. This policy represents a new approach in policy development and at the same time complements other policies introduced by the government. This policy was developed to focus on enhancing the role of the private sector in economic development. Facilitate the development of county’s economy and reducing financial and administrative burden of the government is also the purpose of this approach. Furthermore it attempts to reduce government intervention in the economy, lowering the level and scope of public spending and allowing market forces to determine economic activity in line with the National Development Policy.

During the implementation of this policy, the private sector was regarded as the engine of growth. As a result of this policy, the Malaysian government has successfully reduced its expenditure particularly in the development sector. In 1987, the percentage of development expenditure of total expenditure was marked lowest at about 20%. In general, it is believed that the Malaysian economic policies have had a big influence on the trend of the government expenditures for economic growth. However, this policy leads the policy makers to become divided as whether the expansion of government promotes or impedes economic growth.

As mentioned in the earlier section, there were several studies on the direction of causality between government expenditure and economic growth in Malaysia and the results are mixed. Some concludes that it has no relationship between the government expenditure and economic growth, while some argued there was some positive and significant relationship lies within. However, we presume that the outcome of the same study will possibly lead to either one of the existing results. Furthermore the causality test was unable to identify the degree of change or effect from one variable to another; for this reason this study has no interest in testing for causality.

On the other hand, as highlighted in an earlier section regarding the two sides of arguments which are the proponents of big and small governments, at this point, the attention is given to identify the right side of these two arguments. In addition we would also like to identify the degree of association between the government expenditure particularly by its sectors and economic growth. To our knowledge, no such study exists for Malaysia so far. Thus this study attempts to investigate the association between government expenditure in education and healthcare and economic growth in Malaysia from 1981 to 2013.

Research Objectives

The aims of this study is to evaluate empirically the association between the general government expenditure and economic growth. Specifically, the objectives of this study are:

1.3.1 General Obejctive

To identify the association between government development expenditures and economic growth, and its significance by the services and sector.

1.3.2 Specific Objective

To determine the relationship between the education and economic growth of Malaysia.

To determine the relationship between the defence and security expenditure and economic growth of Malaysia.

To determine the relationship between the general public services expenditure and economic growth of Malaysia.

To determine the relationship between the transportations and communications expenditure and economic growth of Malaysia.

To determine the relationship between the healthcare expenditure and economic growth of Malaysia.

Research Question

To meet the above objectives, several research questions have been developed to meet the objectives. Answering the below research questions will fulfil the objectives of this study.

The research questions are as follows:

What is the relationship between education expenditure and economic growth of Malaysia?

What is the relationship between the defence and security expenditure and economic growth of Malaysia?

What is the relationship between the general public services expenditure and economic growth of Malaysia?

What is the relationship between transportations and communications expenditure and economic growth of Malaysia?

What is the relationship between healthcare expenditure and economic growth of Malaysia?

1.5 General Hypothesis

The hypothesis is to determine the relationship between the government expenditure and economic growth in Malaysia.

EDUCATION

H0: There is a relationship between the education expenditure and economic growth of Malaysia.

H1: There is no relationship between the education expenditure and economic growth of Malaysia.

DEFENCE AND SECURITY

H0: There is a relationship between the defence and security expenditure and economic growth of Malaysia.

H1: There is no relationship between the defence and security expenditure and economic growth of Malaysia.

GENERAL PUBLIC SERVICES

H0: There is a relationship between the general public services expenditure and economic growth of Malaysia.

H1: There is no relationship between the general public services expenditure and economic growth of Malaysia.

TRANSPORTATIONS AND COMMUNICATIONS

H0: There is a relationship between the transportations and communications expenditure and economic growth of Malaysia.

H1: There is no relationship between the transportations and communications expenditure and economic growth of Malaysia.

HEALTHCARE

H0: There is a relationship between the healthcare expenditure and economic growth of Malaysia.

H1: There is no relationship between the healthcare expenditure and economic growth of Malaysia.

In order to proceed with the interpretation of regression analysis, a significance level should be first considered. The significance level can be set at three different levels which are 1%, 5% and 10%. At each significant level, if the p-value of variables indicates that p-value< the significant level (1% or 5% or 10%), it means that we should reject H null. Thus, the independent variable has significant relationship with dependent variable at that significant level. However, in this paper will look at 5% and 10% significance levels to test the variable. At this significance level, at 10% significant level, only if p-value of the variables is less than 0.10 significant level, then H null should rejected. On the top of significant level a strength and direction of the relationship should also be considered. The direction of relationship can be interpreted by identifying the sign (+ or -) on the result of correlation test or coefficient of independent variable in the regression model. The sign (+) means that it has positive relationship while the sign (-) means it has negative relationship. The strength of relationship is determined by measuring the number indicated from correlation test result which ranges from 0 to 1. If the result indicates near to 1, it means that the correlation between variables is strong. If the result indicates near to 0, it means that the correlation between variables is weak.

1.6 Significant of Study

Malaysia is a developing country that has excelled in economic performance during 1980s. However more and more factors are affecting the economic health of Malaysia and the economic performance has slowed down over the years. One of the argument found is on the misspending of the government budget. Government expenditure might have failed to address the real factor that may drive the economic growth; therefore this paper may be helpful in the sense of recognizing the real expenditure that may trigger economic growth. This does help in helping government to spend the right money at the right place.

Identifying the relationship within economic growth and government expenditure will also give some reference to the policy makers in shaping the country’s future without unnecessary waste of resources. It may also help policy makers to examine the current policy, weighting its strength of influence towards the results they may want to achieve.

Furthermore, this paper has also study the government expenditure by separating it into perfect bite-sized, easy to understand and digest. The paper has breakdown the economic expenditure to very small and specific components, and this will help in quantifying the right amount of expenditure in every aspect. This makes the economic analysis become much more an easier and easier to forecast the economic growth by accessing the current expenditure that have invested in.

1.7 Outline of the Study

The following chapters in this study will explain the research process in better details. The structure of this study starts with chapter one focusing on the introduction and research proposal.

Chapter two is about the literature review, this chapter will discuss on the relevant research that have been carried out by others researchers. This chapter will also discuss and explain in depth about the literatures relevant to the area of economic growth.

Chapter three focuses on model and methodology. This chapter will discuss the method that will be used in this research. It included the research design, research method, data analysis and others.

Chapter four conducts the empirical tests of a time series regression analysis from year 1981 to 2013 and describes the outcome of the regression analysis. The results of the research will then be analyzed to answer the relevant research question.

Chapter five focuses on a discussion of the empirical results and discuss conclusions and recommendations based on the study. This part will provide a summary of the findings, a discussion of the implications of the study and recommendation

1.8 Conclusion

In a nutshell, this paper study on the significance of the relationship between government expenditure and economic growth, it is based on secondary data as the paper is accessing the past record of the economic performance to draw a conclusion. The paper will help in certain aspect, especially as a reference in helping policy makers to make a better policy, drive Malaysia towards a more competitive environment.

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